Leading mobile service provider Vodafone Essar Ltd has moved the Bombay High Court challenging a notice issued by the income tax (I-T) department regarding a levy of capital gains tax in the wake of the Vodafone-Hutch deal.

This is perhaps the first time tax authorities are attempting to tax a transaction between two foreign companies involving transfer of an Indian asset.

If the tax liability is established, it could amount to about $1.7 billion, according to the IT notice.

The IT department, however, has said the petition filed by Vodafone Essar is "premature, as no actual demand for capital gain tax has been made by the department."

The matter is expected to come up for hearing next week.

"The I-T department has only issued a show cause notice to Vodafone Essar asking why it should not be treated as an agent of Hutchison International," the department's advocate Benny Chatterjee told IANS Wednesday.

Chatterjee said that the department has yet to carry out an assessment of the transaction and books of accounts, which will be done only after Vodafone Essar responds to the notice.

In the light of this, the income tax department issued a show cause to Vodafone asking it to explain why it (Vodafone-Essar which was formerly Hutchison Essar) should not be treated as an agent of Hutchison International.

Hutchison International had sold a majority stake in Hutchison Essar to Vodafone for $11.2 billion.

Ordinarily, Hutchison (seller) would have to bear this liability. However, since the department does not have access to Hutchison in Hong Kong, they have issued a notice to Vodafone Essar (buyer).

The department wants to treat Vodafone Essar as an agent of the non-resident organisation (Hutchison International) under Section 163 of the Income Tax Act.

Vodafone Essar has challenged this, saying that since the transaction between Hutchison International and Vodafone was structured through Mauritius, it would not attract tax in India.

India and Mauritius have a treaty to avoid double taxation.

Income tax authorities are claiming capital gains under Section 9(1)(i) of the Income-Tax Act as they are of the view that the transaction involved transfer of an Indian asset for which approval of the Foreign Investment Promotion Board (FIPB) was sought.

The I-T notice has sought $1.7 billion as capital gains tax in the $11.2-billion acquisition of Hutchison Telecom International Ltd's 67 per cent stake in Hutch-Essar, now re-christened Vodafone Essar.